ETFs Increase Volatility in the Junk Bond Market
Junk bond exchange traded funds have ten times more money than they did two years ago, and are causing some of the largest price swings ever. Junk bond price swings were seven times higher in November than in May. This volatility in the junk bond market is similar to the volatility seen in other asset classes caused by exchange traded funds. (See Bloomberg “Exchange Traded Junk Funds Roil Bond Market”).
How could this happen when junk bond exchange traded funds make up only 2 percent of the junk bond market? According to the article, it has to do with the market being thinly traded and junk bond exchange traded funds being among the biggest holders of benchmark junk bonds.
“These large concentrations of holdings have a dramatic impact on individual issues,” the head of portfolio management at a California-based affiliate of Pacific Life Insurance Co. which oversees $2.9 billion, was quoted as saying, adding: “When the market is up the offers on these issues will be higher and conversely when the market is lower, or there are expected outflows, bids dry up quickly or are lower on the names held in the ETFs.”
Others argue that junk bond exchange traded funds are not creating volatility but are merely reflecting the true volatility of the junk bond market. “Uncertainty breeds volatility,” the global head of strategy and consulting at State Street’s ETF group, was quoted as saying, adding: “The volatility that’s being expressed in the marketplace is much more reflective of what’s going on in the broader marketplace.”
Similarly, the head of iShares Fixed Income Strategy at BlackRock was quoted as saying that its junk bond fund “has made the high-yield market visible for the first time for investors. They hadn’t realized that the high-yield market was that volatile. It was always that volatile; it just wasn’t that easy to see.”
In any case, junk bond exchange traded funds have underperformed the junk bond market. According to the article, since inception, the BlackRock’s iShares iBoxx High Yield Corporate Bond Fund has returned 28.2 percent and a similar State Street ETF has returned 25.6 percent, while junk bonds, on average, returned 40 percent since April 2007.
“It’s very hard for an ETF to beat the index, and even the average manager, considering how much forced trading an ETF has to do in a relatively illiquid market,” Gershon Distenfeld, who oversees high-yield credit investments at AllianceBernstein LP, was quoted as saying.
Page Perry, LLC is an Atlanta-based law firm with over 170 years collective experience protecting investor rights and fighting Wall Street greed.
